The Effects of Employment Protection: Learning from Variable Enforcement

The purpose of this paper is threefold i) extend standard models of employment protection legislation (EPL) allowing for disciplinary as well as economic dismissals, ii) explain why EPL is typically not enforced in the case of small units and iii) provide new evidence on the relationship between strictness of EPL and job loss as well as EPL thresholds and growth of firms. Unlike previous studies drawing on cross-country variation, in this paper inferences are made by exploiting the within country variation in the enforcement of EPL. Regulations on dismissals typically allow for a threshold scale (generally defined in terms of the number of employees) below which the most restrictive EPL provisions (e.g., the compulsory reintegration in case of unjustified dismissal) are not enforced, the legal procedures for firings are eased, or severance payments are diminished. In this paper we develop a simple theoretical model to illustrate the rationale for these exemptions, and use this discontinuity in regulations (as well as the divide between fixed-term and permanent contracts) to infer the effects of EPL within a double-difference approach.